Church House CEO Jeremy Wharton provides an in-depth review of global credit markets over the last quarter
As inflation rages everywhere, in a so far unchecked manner, markets remain fixated on economic indicators, none of which make pleasant viewing. Whether it is the price of gas in Europe or UK baseload electricity pricing for winter, some of these charts resemble technology stocks in the bubble of 1999/2000 and are a source of concern. Risk assets continue to struggle under relentless poor economic news and hawkish Central Banks. The rally in July/August fizzled out when a particularly hefty US inflation figure extinguished any hopes of a ‘pivot’ (a pause or even a turn in the cycle) from the Federal Reserve and the dollar continues to be all powerful. Recent Purchasing Manager Indices (PMIs) from developed economies make dismal reading and coupled with still elevated inflation expectations and collapsing consumer confidence, it is hard to see these reversing any time soon.
The Federal Reserve continued with its aggressive stance, hiking by another 75bp to 2.50% in July and then a further 75bp in September taking the Fed Funds Rate to 3.25%. They seem happy to remain as hawkish as possible with increasingly stark language and they appear to have every intention of keeping going, ‘forward guidance’ is not as dead as some anticipated. Due to the pace of their rate increases, some began to speculate on when they might back off or even hope for a pivot but, with continued strong employment numbers, this looks like wishful thinking. Faltering global demand will eventually manifest itself in lower levels of economic activity. In contrast, China cut rates and is providing funding to developers in a continued effort to support its property market.
The eurozone continues to see elevated inflation levels despite some temporary measures to ease prices for consumers. Energy prices remain the biggest contributor to inflation as household gas prices surged 66% year-on-year in July alone. Despite delivering a 50bp hike (to zero) the ECB remained the Central Bank the most behind the curve and the euro has slipped below parity to the US dollar. The ECB then delivered a 75bp hike in September, and there is a chance that the eurozone was already in recession in the third quarter, with Germany slowing the most. Eurozone employment numbers however continue to be strong, which is some consolation and France is better insulated than the rest from Putin’s pain.
In the UK we have our own problems and release of the next energy price cap on top of 10% inflation led to a sharp drop in consumer confidence. The Bank of England’s MPC raised rates by the most in twenty-five years when it hiked by 50bp to 1.75% in August while sticking to their new language to act ‘forcefully’ to tackle inflation. The Gilt curve now trades almost flat out to ten years (i.e. two-year interest rates at 4% are the same as ten-year rates) providing little incentive to add duration. We had a further 50bp rise in September from the Bank (when the market expected 75bp – three MPC members did vote for that magnitude), taking Base rates to 2.25% and beleaguered ‘cable’ (sterling/dollar) suffered another leg down. In fairness, the Bank was waiting for the next day’s ‘fiscal review’ when the chancellor’s tax cuts, energy price caps and dramatic fiscal loosening were all supposed to stimulate growth back to a 2.5% target. This put fiscal policy in direct opposition to the monetary tightening path of the Bank and involves raising huge amounts from the sale of Gilts just at the time that the Bank itself begins active sales of Gilts from its own balance sheet.
Enter Truss and Kwasi Kwarteng into proceedings in a year that has already seen intense and sustained pressure on stocks, bonds and currencies. Their arrogance (or naivety) towards markets was only matched by the stupidity of their totally unfunded fiscal plans. They discovered the hard way that markets can take fright very quickly when informed that they would have to wait for nearly two months to be told of the plan to fund what might be up to a £200bn bill. Cable sank to a 1.0392 all-time low (with all the potential further inflationary consequences of a weak currency – do they understand this?) and ‘risk-free’ assets (Gilts) became very risky indeed, especially as the long end of the Gilt curve collapsed under the self-reinforcing selling of Gilts to fund margin calls for geared pension fund LDI (liability driven investment) strategies.
Thankfully, the Bank intervened to stabilise the market, putting in place yet another Asset Purchase Facility to support long-dated Gilts by holding auctions on a daily basis (for two weeks initially) undertaking to spend up to £5bn a day (a reversal of the Quantitative Tightening that they were just commencing). In practice (by day 6), they have bought less than £5bn of Gilts in total, with zero bought on day 5 (rather less than the £65bn being reported by the BBC) and have restored some calm.
Volatility in rates markets hadn’t derailed the primary market in corporate credit, and although issuance levels were not the same as last year, they were still healthy. In High Grade credit the primary market managed to price plenty of new issues, though pricing power was in the hands of lenders rather than borrowers. Some issues still offered little incentive to the investor, why people want to lend money to Apple for up to forty years so it can fund share buybacks is baffling, although it is one of only three AAA rated corporates. The recent elevated volatility has put many issues on hold for a while and the sterling credit primary market for lower-grade issuance remains shut.
Credit spreads were relatively stable until the end of September with orderly widening in euro and sterling markets. Trussonomics put paid to that, and credit spreads globally have widened to levels not seen since the worst of the panic during the Covid pandemic. There still is some complacency regarding potential default rates in lower grade credit, but with precious few being able to access the primary market to refinance it looks inevitable that these will increase.
The full Quarterly Review is available here.
The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment arrangements.
Please also note the value of investments and the income you get from them may fall as well as rise, and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future performance.